In Letter, Warren Buffett Concedes a Tough Year

Sunday

Mar 1, 2009 at 4:09 AM

In his annual letter to shareholders, Warren E. Buffett chided himself but also needled regulators and chief executives.

DAVID SEGAL

The renowned investor Warren E. Buffett chided himself and the business world at large in his annual letter to shareholders of his holding company on Saturday as he sifted through the wreckage of his worst year in four decades.

Mr. Buffett’s company, Berkshire Hathaway, reported a 62 percent drop in net income for 2008 and posted a decline in book value per share for only the second time since he took control in 1965. Shares of the company, which peaked in late 2007 at more than $148,000 apiece, closed Friday at $78,600.

With characteristic candor, Mr. Buffett, 78, took the blame for some of the declines, stating that he “did some dumb things,” lamenting in particular an ill-timed bet on oil and the purchase of shares in two Irish banks, which have fared poorly. But he also needled regulators and an assortment of unnamed chief executives as he predicted that fallout from the credit crisis would leave the stock market a shambles through 2009.

The letter, as ever, gives shareholders an overview of Berkshire’s annual performance, but it also doubles as a folksy state-of-the-economy address from Mr. Buffett, one of the country’s most revered investors.

In language that was by turns blunt and witty, he decried what he called “a series of life-threatening problems within many of the world’s great financial institutions.” An inveterate optimist about the American economy, Mr. Buffett also forecast an eventual recovery, asserting that the country has faced even more severe economic travails in the past.

“Without fail,” he noted, “we’ve overcome them.”

Despite its record losses, Berkshire Hathaway still has about $25 billion of cash on hand and has been buying preferred shares of General Electric and Goldman Sachs, as well as the debt of companies like Harley-Davidson and Tiffany & Company. Mr. Buffett is shopping for bargains while the share prices of most companies are sliding — his own portfolio included.

Shares of many of his top 20 holdings suffered losses last year, among them Coca-Cola, American Express and ConocoPhillips.

Since the beginning of the recession, Mr. Buffett has taken on a part-time and unofficial role as the United States economy’s éminence grise. He also served on President Obama’s transition team. In his letter, though, he lambasted the decisions and habits that led to the credit crisis.

In reviewing the performance of Clayton Homes, a Berkshire Hathaway subsidiary that sells manufactured homes, he pointed out that its lending arm had managed to keep foreclosure rates to less than 4 percent, even among subprime borrowers, or those with weak credit ratings.

He contrasted that relative success with the failures of just about everyone else in the same business.

“The stupefying losses in mortgage-related securities came in large part because of flawed, history-based models used by salesmen, rating agencies and investors,” he wrote.

He went on: “These parties looked at loss experience over periods when home prices rose only moderately and speculation in houses was negligible. They then made this experience a yardstick for evaluating future losses. They blissfully ignored the fact that house prices had recently skyrocketed, loan practices had deteriorated and many buyers had opted for houses they couldn’t afford.”

Also blissfully ignored, he wrote, were the perils of relying on mathematical models devised without worst-case situations in mind. Too often, he wrote, Americans have been enamored of “a nerdy-sounding priesthood, using esoteric terms such as beta, gamma, sigma and the like.”

Some skepticism about these models is overdue, he added. “Our advice: Beware of geeks bearing formulas.”

Mr. Buffett was just as scathing on the subject of derivatives, which he had likened to weapons of mass destruction long before they started eviscerating the balance sheets of banks around the world.

In his letter, Mr. Buffett explained that the danger of derivatives was not merely the difficulty in assessing their value; rather, it was the “web of mutual dependence” they create among financial institutions. Derivatives contracts keep various parties entangled for years, which, as he vividly explained, can create real hazards once those assets start deteriorating.

“Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease,” he wrote. “It’s not just whom you sleep with, but also whom they are sleeping with.”

Mr. Buffett’s report was greeted with sighs of relief among some shareholders. “I’m delighted,” said Janet Tavakoli, a derivatives expert and author of “Dear Mr. Buffett,” about the credit crisis of 2008.

“Of course it was a tough year — the toughest year of his life. But I was concerned about the impact in operating earnings and I was prepared for much worse.”

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